How to build an emergency fund? A step by step guide!
Nov 22, 2022 - 3 min read
We discussed about what an emergency fund is and why we need to have one in our previous article. In this article, we discuss step by step guide to creating an emergency fund.
1. Calculate the size of your emergency fund!
There is no “one size fits all” formula to determine the amount of your emergency fund. But a rule of thumb is to set aside enough money to cover at least 3 to 6 months of your household expenses (for you and your family).
For example: if your average monthly household expense is Rs. 50,000 then your emergency fund should have at least Rs. 1,50,000 to start with and you can continue to increase your fund once you meet the initial goal.
2. Set a goal
The next step is to set a monthly goal to put a certain amount of money into the emergency fund. You may start by putting 5 to 10% of your monthly income in the emergency fund.
For example: If your monthly income is Rs. 75,000/-, you may start by setting aside Rs. 5,000 to Rs. 7,500 for your emergency fund.
3. Decide where to keep your emergency fund
The money in your emergency fund should be available the moment you want it. So make sure you either keep it as cash or a separate bank account. Recurring fixed deposits may be a good idea too where you can earn interest from your money.
Caution: Do not put your emergency fund in investments like shares or as loans to others. These may be difficult to convert to cash at the time of your needs.
4. Make the contribution automatic
As far as possible, make the contribution to your emergency fund automatic. That means whenever you receive your monthly income then your contribution to the emergency fund should automatically go to the concerned account.
For example: You may start a recurring FD with your bank allowing the bank to transfer the amount directly every month or if you are a salaried person, then you may ask your employer to deduct a certain amount from your salary and deposit it to some funds like CIT, PF etc. But make sure that the money is deposited on time.
5. Regularly monitor your progress
Keep on checking your balances in the emergency fund to see your progress and how far are you from reaching your goal. This will help you to stay motivated and be on track!
Note: Monitoring your progress will also help you to ensure that the money is actually in your emergency fund if you have asked your employer to deduct it and deposit to your emergency fund account or you have chosen a recurring fixed deposit.
6. Assess, adjust & celebrate!
Creating and maintaining an emergency fund is not a one time practice or a short term activity. As time passes, your expenses increase due to various reasons. Like inflation, addition of new family members etc. will require you to revise the size of your emergency fund and keep on contributing.
For example: If your target was to create an emergency fund that is enough to cover your expenses for 3 months, then what to do after you achieve it? Well increase the size of your fund. But before that celebrate your success! You are one step away from any financial stress and another step closer to your financial well-being!
As you can see, in order to start any good financial practice, you should be aware of your financial condition and behavior.
How do you do that? Start tracking your money flow. Record your income and expenses. Then you will know where you are and it will be easier for you to decide where you want to be!
And we at Khatapana are here to help you. Sign up for Khatapana today and take the first step towards financial wellbeing.